An extremist, not a fanatic

September 30, 2014

For a long time, I've argued that government borrowing is due is large part to the corporate sector's financial surplus - its excess of retained profits over capital spending. However, today's GDP figures show that something else is also happening.

These show that the corporate sector's surplus has disappeared; in fact, in Q2, companies in aggregate ran a small deficit. However, although the declining corporate surplus has been accompanied by falling government borrowing, the latter is still large. Why?

Statistically speaking, the main counterpart to government borrowing is no longer corporate net lending but rather overseas net lending - or, to put it more familiarly, a current account deficit. It is foreigners' net saving, rather than companies', that is the counterpart of government dissaving.

Of course, "counterpart" does not tell us anything about causality. So, what is the direction of causality?

You could argue that our borrowing from overseas is caused by government borrowing. Maybe government borrowing has inflated demand which in turn has sucked in imports.

Now, whilst this has happened sometimes, it is not the case here and now. Several facts tell us as much: that UK real interest rates are negative; that there are 5.65m unemployed; that inflation is low; and that real GDP has grown only 2.9 per cent in the last six years.

Perhaps, therefore, the correlation goes the other way - it is foreigners' saving that is causing UK government borrowing. Weak demand overseas means weak UK exports which means a weak economy and tax revenues.

To put it another way, in the much of the world savings exceed domestic investment. This might be because of big oil revenues (the middle east);weak welfare states and capital markets (China) or being daft twats (the euro area). Whatever the causes, such net saving means - by definition - that someone somewhere must borrow. This someone is partly the US, but also the UK government. This explanation is consistent with the fact that UK government borrowing has been accompanied by negative real interest rates.

Which brings me to a puzzle. We British tend to blame foreigners for lots of things, from unemployment to the craptacularness of the England football team.Such blame is generally wrong. And yet when foreigners might be responsible for one of our problems (assuming the deficit to be such), nobody points this out.

September 29, 2014

Here's a glorious example of the media's bubblethink: the Guardian's political reporters describe Osborne's stewardship of the economy as the Tories "strongest card."

Let's just remind ourselves of the facts. Back in June 2010 the OBR forecast (pdf) that real GDP would grow by a cumulative 8.2% in between 2010 and 2013. In fact, it grew by only 3.1%. Partly because of this, the deficit is much larger now than expected. In 2010, the OBR forecast that PSNB in 2014-15 would be £37bn, or 2.1% of GDP. It now expects it to be £83.9bn, or 5.5% of GDP.

This poses the question: how can such failure be regarded by the Bubble as success? Here are five possibilities:

1. The peak-end rule. Daniel Kahneman has shown (pdf) that our memory of events is distorted by how they end, so that great pain followed by discomfort is regarded more favourably than pain alone, even if the former episode goes on for longer. The fact that the economy is now growing therefore leads us to under-estimate the pain of the stagnation of 2011-12 - just as our relief at finally getting home causes us to overlook the fact that the cab-driver took us on a two-hour detour.

2. Luck. The collapse of productivity growth means that the modest growth we've seen has translated into surprisingly strong jobs growth, for which Osborne is (wrongly) getting credit. In fact, if productivity had grown at a normalish rate in recent years, unemployment would have hit a record high. I doubt if Osborne would be regarded as a success in that case.

3. Risk aversion and status quo bias. People prefer the devil they know - and Osborne's stewardship is better known than Labour's policies.

4. False excuses. The coalition has tried to blame the euro area's weakness for our weak growth. This, though, won't wash; a policy that works only if everything goes OK is no policy at all, given that surprises are inevitable.

5. Managerialist machismo. If you use the language of "tough choices" and "prudence", some people will take you at your word. As Cameron Anderson and Sebastien Brion have shown, overconfident people who give off competence cues are wrongly seen by others as having genuine competence.

Whatever the reason, the fact is that it is only within the groupthink bubble that Osborne's macroeconomic policies can possibly be regarded as a success.

September 27, 2014

In the Times, Danny Finkelstein expresses disquiet about Operation Yewtree:

"My word against some bloke after more than 20 years is good enough for you?" [Liz Kershaw] asked. The police wouldn't need other evidence to charge?"Well" replied the officer. "If it was just one girl obviously the Crown Prosecution Serivce would probably throw it out. But if more than one girl came forward, well..."The clearest statement I have ever seen of the dubious policy of using legally weak individual allegations to support each other.

If lots of women were to independently make allegations against someone, those allegations might be credible - though whether credible enough to overcome the reasonable doubt hurdle is another matter. The problem comes when the allegations might be correlated. If one allegation against a public figure encourages others to make allegations, the subsequent allegations might not have as much weight as they would if they were independent. The latter allegations might be cases of misremembering or mistaken identity. If so, there's a danger of an information cascade; several allegations might be due not to independent pieces of information which support each other but to a common mistake.

Now, I've used the word "might" a lot in that paragraph. But we do have a much clearer example of the danger of correlation neglect in criminal law. In 1999 Sally Clark was convicted of murdering her two babies on the evidence of a pathologist who claimed that the chances of two babies dying of cot death as Ms Clark claimed were vanishingly small. His statement was an example of correlation neglect; it might have been true if the chance of one baby suffering cot death were independent of the chance of his brother dying. But if there are common environmental risks of cot death, then the chances are correlated, so the chances of two deaths are much higher than the pathologist claimed. Ms Clark was eventually released on appeal.

It's not just prosecutors who are prone to correlation neglect. It also happens in investing. Benjamin Enke and Florian Zimmerman show that people fail to discount correlated signals about future returns, and so over-invest in assets which look good. And Erik Eyster and Georg Weizsacker show that investors treat (pdf) correlated assets as uncorrelated and so fail to diversify risk properly.

And, of course, it also happens in politics. We fail to discount the political opinions of our friends because they are correlated: our friends tend to have similar backgrounds and outlooks on life. We are, say (pdf) Glaeser and Sunstein, "credulous Bayesians", who over-react to weak information.

Such correlation neglect contributes to the bubblethink I discussed yesterday. It also generates political polarization (pdf) and overconfidence; Enke and Zimmerman show that it can be a source of stock market bubbles because investors become overconfident about future returns. In the legal context, such overconfidence can lead to false convictions.

These, of course, can have terrible effects: after she was released, Ms Clark drank herself to death. In this sense, correlation neglect can be deadly. Whether this has any relevance to the UK's decision to go to war in Iraq is a question I shall leave to others.

September 26, 2014

Mr Miliband...would rather forget about the deficit and talk about something else. Alas, this is not a viable choice because reality keeps forcing its way in.

Whoa there. Who's reality? It not the reality of the markets, where real gilt yields are negative and there's a shortage of safe assets. It's not the reality of an economy where the deficit is largely due to still-high unemployment and weak incomes growth. It's not the reality of an economy that's "crying out for public stimulus". And it's not the reality where our most fundamental problem is not the deficit but stagnant productivity.

What we have here is yet another example of what Simon calls mediamacro. I suspect, though, that this is the symptom of an underlying disease - that the media exists entirely within a Westminster bubble. Mr Collins thinks the deficit is a "real" problem not because there's empirical or theoretical evidence that it is, but simply because the groupthink of Very Serious People says so.

This is not the only example of Bubblethink. Another habit of the Bubble is to overestimate the number of well-paid people like themselves. This gave us the utterly cretinous headline in yesterday's Times: "Middle class? You'll be ruined by a mansion tax."

Such Bubblethink feeds on itself. One way in which it does so is by current affairs programmes relying upon a circle-jerk of gobshites to the exclusion of experts who might prick the bubble; the fact that James Delingtwat appears on the BBC more than Simon Wren-Lewis tells you all you need to know.

Another way in which it does so is through the BBC's fictitious pursuit of "due impartiality", which promotes the belief that impartiality between two parties with imbecilic ideas about the deficit or economic effects of immigration somehow represents the truth. This was brilliantly lampooned by Alexander Cockburn:

Hunter-Gault: A few critics of slavery argue that it should be abolished outright. One of them is Mr.Wilberforce. Mr. Wilberforce, why abolish slavery?Wilberforce: It is immoral for one man ...Macneil: Mr. Wilberforce, we’re running out of time, I’m afraid.

Although that was written 32 years ago, nothing much has changed.

Herein lies a thought. There's some evidence that our brighter politicians are aware of the dangers of Bubblethink - perhaps more so than much of the media. Could it be, then, that the Westminster bubble describes the media more than politicians?

September 25, 2014

Some of the opposition to Labour's proposed mansion tax seems to me to be confusing bugs with features.

For example, in the Times (£) Janice Turner claims the tax will hit "shabby family houses" which have soared in price because of the property explosion. But this is precisely the virtue of land taxes. London's house prices have soared for several reasons, but none of them because of the efforts of their owners. It's fair to tax people if they reap a benefit with no effort. And as for £2m being "shabby", Hugo Rifkind's tweet was right:

Anybody who says "perfectly normal houses in London now cost £2m" is welcome to buy my perfectly normal house in London anytime they like.

Similarly, Allister Heath says the tax would force people on low incomes to sell up. But this too is a feature, not a bug. Forcing such people out of their homes would free up the houses for those who need them more - families or people who need to be close to where they work.It thus ensures a more efficient use of the housing stock.

Jay Elwes objects that it would be difficult to value houses. I'm not sure. We know the price at which houses changed hands, and it should be straightforward to apply an inflation rate to those prices. I suspect this is just an example of the status quo bias - an objection to policies simply because they don't exist. Imagine if we had serious land taxes and someone proposed a tax on profits instead:

Are you mad? Do you know how difficult it is to measure profits accurately, and how easy they are to fiddle or to shift overseas? Only a fool would want to tax profits rather than land.

However, I don't want to wholly condemn the tax's opponents. When he says that the tax is "an arbitrary confiscation of wealth", Mr Heath has a point in two different senses.

First, taxes on assets should be capitalized into prices; if people expect to pay a tax on an asset, they'll pay less for it. This provides a double blow to current owners of £2m properties; they'll both have to pay tax and they'll suffer a capital loss. But it means that the future rich who'll want to buy a mansion won't suffer at all. Sure, they'll have to pay a tax on their mansion. But they'll have bought the mansion cheaper than they otherwise would because of the tax. It's a wash. In this sense, the mansion tax penalizes today's owners of expensive homes whilst leaving tomorrow's owners unscathed.

Secondly, there'll be some beneficiaries of this tax. People who own homes slightly less than £2m could see a capital gain, as buyers of £2m+ house switch to slightly cheaper properties. (Here's what sub-£2m buys near me.) I reckon that people who own houses woth around £1.8m are quite well off. On both counts, then, I sympathize with Mr Heath; this does seem arbitrary.

The solution to the second problem is straightforward (in theory!). As Ben Southwood says, council tax could be rejigged to become more progressive.

The first problem, however, remains. One solution would be to raise income tax on the rich. But that would raise far more opposition than there is to a mansion tax.

September 24, 2014

Despite his denials, I suspect that Ed Miliband "forgot" to mention the deficit in his speech yesterday for the same reason schoolboys forget their homework - because they don't care about it.

If I'm right, he has an excellent antecedent. Back in 1933, Maynard Keynes said:

Look after the unemployment, and the Budget will look after itself.

But is Keynes' saying still relevant? My chart shows the result of a simple test. It shows the regression of public sector net borrowing as a share of GDP upon the unemployment rate, plus lagged unemployment over the past 10 quarters.

I'm defining unemployment as the officially unemployed, plus the inactive who want a job: ONS data on this began in 1993, so the lags mean our data starts in 1996. And I'm using lags of unemployment because some taxes (such as corporation tax) only flow to the Treasury with a long lag.

My chart shows three things.

First, that there's a close relationship between the two: the R-squared is 75%, implying that Keynes was three-quarters right*.

Secondly, pretty much all the rise in the deficit between 2007 and 2010 is explicable by unemployment. In this sense, the deficit was cyclical.

Thirdly, in the last two years the deficit has been higher than unemployment would predict. You could interpret this as a sign of a "structural" deficit. But if you do, it's one that has emerged only since 2012. And it's no bigger than the "structural" deficit of 2005 - and you'll remember the great fiscal crisis of that year. Not.

In fact, I suspect there's a simple reason for this gap. It's simply that the drop in unemployment overstates the health of the economy. Joblessness has declined not just because the economy has grown buty because productivity has stagnated. This means we have not seen the rises in wages and profits we usually see when joblessness declines, and so tax revenues haven't risen as much as they should have.

In this sense, we might rephrase Keynes: look after unemployment and productivity, and the Budget will look after itself.

Now, I'll concede that I might be wrong here. Maybe there is indeed a "structural" deficit that requires significant fiscal tightening. But I'll need better evidence than estimates which are based upon the mumbo-jumbo idea of an output gap. And in the absence of such evidence, we should at least entertain the possibility that the deficit doesn't matter. Maybe therefore Miliband was right to forget it, as there are much higher priorities.

* I suppose one might argue that the relationship is the other way round, and deficits cause unemployment 18 months previously. Feel free to provide empirical evidence that this is the case.

September 23, 2014

Your job is to criticize Ed Miliband. Of course, this might be because he's doing a bad job. But it's also because you are well-paid and privately educated, and so naturally unsympathetic to most Labour leaders. You will, therefore, want to oppose him whatever he does.

In this regard, you can learn from your colleagues on the sports desk. After years of practice they have perfected the art of condemning Arsene Wenger regardless of facts or logic. Their tricks can be adapted to Ed Miliband, for example:

1. Everything can be redescribed; if a man walks on water, say he can't swim. When Arsenal played better in the second half than the first at Everton it was because Wenger got his tactics wrong in the first half, whereas when Chelsea did better in the second period against Leicester, it was because Mourinho gave a brilliant half-time team talk. You can do the same for Miliband. Redescribe his intelligence as nerdiness. And if he looks like being popular with Labour activists, say he is out of touch with "middle England" - where "middle England is the 5% of voters like you.

2. The double whammy. When Arsenal had Patrick Vieira, Wenger's teams lacked discipline. Now they have a better disciplinary record, they have a soft centre. The same trick works for Labour leaders. If they seem out of touch with voters, emphasize their weirdness. If not, accuse them of populism.

3. See problems where none exist. Just as every defeat for Arsenal is a crisis, so keep asking what Labour plans to do about the deficit, even though most economists and investors don't care.

4. Never look for reasonable motives. When Wenger said he would happily pay £42m again for Ozil, he was accused of being stubborn rather than of wanting to boost Ozil's confidence. Similarly, you must say Ed Miliband's inactivity during the Scottish referendum was due to weak leadership rather than to a desire to avoid someone else's mess.

5. Avoid details. Football pundits claim that Wenger can't coach defending - forgetting that only the money-launderers kept more clean sheets than Arsenal last season - without saying precisely how to improve the defence. Similarly, you should demand that Miliband appeal more to voters in the south, without saying how.

6. Confuse luck with skill. Pundits claim that Arsenal's long injury list down the years is due to Wenger's bad management rather than bad luck - though, heeding point 5, they never say precisely how. Similarly, you should say that falling unemployment shows that Labour's criticism of Tory austerity was mistaken, and not point out that this has only happened thanks to an unexpected collapse in productivity growth.

7. Ignore the fact that there are trade-offs. The pundits accuse Arsenal of defensive naivete because their fullbacks play high up the pitch. If they played deeper, however, the same gobshites experts would say Arsenal were over-run in midfield. The same trick works in politics. If Labour says little about the deficit, accuse them of lacking "credibility". If they have plans to reduce it, accuse them of tax bombshells and wanting to slash defence spending.

8. Never, ever mention the elephant in the room. Football writers (with the honorable exception of the gerat Matthew Syed) rarely point out that Wenger's relative lack of success in the last few years is because his rivals have spent hundreds of millions of pounds of stolen money. Similarly, you must never say that the biggest problem labour leaders face is that the power of the rich greatly constrains what any social democratic government can achieve. Pretend the game isn't rigged.

September 22, 2014

At the end of an interview with Ed Balls this morning, Sarah Monague (02h 22m in) gave us a wonderful example of the ideological presumptions of supposedly neutral BBC reporting. She asked Nick Robinson: "It's about economic credibility here, isn't it?"

What's going on here is a double ideological trick.

First, "credibility" is defined in terms of whether Labour's plans are sufficiently fiscally tight*. This imparts an austerity bias to political discourse. There's no necessary reason for this. We might instead define credibility in terms of whether the party is offering enough to working people, and decry the derisory rise in the minimum wage as lacking credibility from the point of view of the objective of improving the lot of the low-paid.

Which brings me to a second trick. Credible with whom? We might ask: are Balls' policies credible with bond markets - the guys who lend governments money - or will they instead cause a significant rise in borrowing costs? Or we could ask: are they credible with working people? But neither she nor Nick presented any evidence about either group. The judges of what's credible seem to be her and Nick themselves - who, not uncoincidentally, are wealthy, public school-educated people.

This poses the question: what is the origin of this double bias?

It's tempting to say that it is a simple right-wing bias; why should people from public schools on six-figure salaries think that politics should concern itself with the living standards of ordinary people?

But maybe it isn't. What we're seeing here might be yet another example of an idea that's outlived its usefulness.

There was a time when the credibility of fiscal policy mattered; in the 70s and 80s, social democratic governments in the UK and France were constrained by the bond market vigilantes. But this is no longer the case. We live in a world of a savings glut and safe asset shortage. The bond vigilantes have gone home. Maybe Balls' looser fiscal policy might raise bond yields a little. But does this matter much when they are negative? However, Montague and Robinson haven't adapted to this new world, and - like all mad people in authority - are the slaves of some defunct economist.

So, I'm not sure what the reason for Montague's bias is. But I do know that the idea that the BBC is neutral is just...

September 21, 2014

Is capitalism compatible with decent living standards for the worst off*? This old Marxian question is outside the Overton window, but it's the one raised by Ed Miliband's promise to raise the minimum wage to £8 by 2020.

First, the maths. This implies a rise of 4.2% per year; the NMW will be £6.50 from next month. However, as the NMW rises, workers' incomes don't rise one-for-one, because tax credits get withdrawn. Assuming an average deduction rate of 50% (it varies depending on whether workers have children - see chart 5.8 in this pdf), this implies a rise of 2.1% per year. However, if the OBR's forecasts are correct, CPI inflation will average 2% over 2015-20.

Miliband's promise, therefore, amounts to little better than a pledge that the incomes of the low paid won't fall in real terms - and not even that much, to the extent that inflation might exceed target.

Now, in fairness, Labour might well do more to help the low-paid by, say, increasing the generosity of in-work benefits. But promising to do this before the election would merely run into the question from dickhead journalists: "where will the money come from?" So it's best for Labour to under-promise.

Nevertheless, the raises the issue: what would serious policies to help the low-paid entail? I suspect they would require:

- Macroeconomic policies to boost employment. If you ensure a high demand for labour, you might eventually raise its price.

- A serious jobs guarantee; this would help give work to the less skilled, who might not benefit so much from higher aggregate demand alone.

- Policies to strengthen the bargaining power of low-paid workers. These could include stronger trades unions (pdf), but I'd add a citizens' basic income, which would give workers a guaranteed outside income, and so empower them to reject exploitative jobs.

This brings me to my opening question. Are these policies compatible with capitalism? On the one hand, yes - because higher aggregate demand would raise the mass of profits. But on the other hand, no**. For one thing, as Kalecki famously pointed out, macro policies to increase employment would weaken capitalists' political power by making business confidence less important for growth. And for another thing, more bargaining power for workers means less for capitalists. It's moot.

But this is precisely the debate we should be having. It could be that, whilst the constraints imposed by capitalism are tight, Labour might be over-estimating their tightness, and so will under-deliver for the low-paid.

* Note for rightists: As Adam Smith said, the notion of what's decent rises as incomes rise. And the fact that capitalism has massively improved workers' living standards in the past does not guarantee it will do so in future. As Marx said, a mode of production which increases productive powers can eventually restrain them. And as Bertrand Russell pointed out, inductive reasoning can go badly wrong.

September 20, 2014

No, I'm not trying for an improbable libel action. I'm referring to his call for a fiscal council. He says:

Politicians will believe anything that suits them. But what the independence referendum showed us is that voters have similar problems. As the campaign progressed the stronger the Yes vote became, and there is some evidence that this reflected additional information they received. As I suggested here, the problem is that this information was superficially credible sounding stuff from either side, but often with no indication from those who might have known better of the quality of the analysis.

There are ( at least) three relevant mechanisms here:

- Knowledge produces overconfidence. It's not just in politics that this is the case. It also happens when people are putting their own money at stake. For example, even well-informed investors are prone (pdf) to buying poorly perforning, high-charging funds because they erroneously believe that their knowledge gives them the ability to spot good funds.

- A selection bias. People get interested in politics because they believe that politics matters (like, duh). This means that those who speak on political affairs - not just professionals but blokes in pubs - are disproportionately likely to overstate the ability of policies to improve the economy when, in truth, as Simon says, "most of the time the macroeconomy stubbornly refuses to be impressed".

- AsymmetricBayesianism. As we learn more about an issue, we learn the faults in our opponents' arguments whilst giving our own an easy ride. Thus, knowledge produces dogmatism.

For these reasons, even a quite well-informed electorate might have mistaken preferences.

Which is where I'm reminded of Moe. In The Gilded Truffle, he says: "Bring us the finest food you've got stuffed with the second finest."

The waiter replies: "Excellent sir. Lobster, stuffed with Tacos."

It's here that there's a role for fiscal councils. Think of them as food experts, telling us that the food we want might be expensive, bad for us or just not as tasty as we'd like - and, maybe occasionally, pointing us to cheap and tasty alternatives.

You might think that, in the IFS, we already have impartial fiscal experts. Sadly, though, its Mirrlees review has merely served as Exhibit A for Alan Blinder's famous remark, that economists have the least influence where they know the most. One case for putting a fiscal council onto a statutory basis is that doing so might cause people to pay more attention to it. Far from being undemocratic, such a council should improve the quality of democracy, by raising the quality of debate.

In this respect, its success requires two things. One is that its function be limited. If the council gets into the idiot business of forecasting, it will soon discredit itself.

The other is that the council should be explicit about the limits of what we know - for example that it's difficult to estimate Laffer curves precisely. The function of experts is not merely to introduce knowledge into the public realm, but also doubt.